A pessimist is never disappointed - except when it comes to planning their retirement income. In that instance, being unduly gloomy will cost them dear and leave them very disappointed indeed.
That’s because underestimating how long you’ll live - guessing that you will die much sooner than you actually will - can lead you to take bad decisions about managing your retirement income. You may burn through your retirement savings too quickly, assuming you won’t be around for long once they’ve run out. Or you might choose the wrong form of retirement income entirely.
This second mistake is the subject of new research from the Institute of Fiscal Studies (IFS). In a paper called ‘Survival pessimism and the demand for annuities’, the IFS attempts to quantify what impact underestimating life-expectancy is having on retirement choices, and the choice whether to take an annuity in particular.
Prior to the introduction of pension freedom reforms in April 2015, far greater numbers of people used their pension pot to buy an annuity, the product that turns savings into a guaranteed income for life. When the rules changed, many more of these people were eligible to access their savings with full flexibility, in either lump sums or through drawdown - taking income payments from an invested pot that could eventually run out.
As an insurance product, the rate of income an annuity pays depends on underwriting and the insurer’s view of your expected lifespan. To form that view it will ask you about all aspects of your health, lifestyle and other circumstances and then use this information in comparison with the information it has about other people to make a guess at your life expectancy. The income it offers you depends on this calculation.
Because the income is guaranteed until you die, the length of time you live is what determines whether the annuity is good value or not. Die the day after purchase and it would prove very poor value indeed. Live 20 years longer than anyone expected, and you’ll be quids-in.
As highlighted in the IFS work, many people have been declining the guaranteed income of annuities and instead opting the potentially higher, but not guaranteed, income from drawdown. That’s consistent with them underestimating their own life expectancy.
The problem comes if they go on to live much longer than they expect. If that happens, their decision to reject an annuity will have cost them in lost income.
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Fidelity Personal Investing has conducted its own research in this area which showed exactly how easy it is to underestimate rising life expectancy. Carried out in conjunction with the Oxford Institute of Population Ageing, it showed that today’s 45-year-olds can expect to live almost three years longer on average than today’s 65-year-olds.
Underestimating life expectancy is one of the reasons the IFS gives for annuity sales falling. While 90% of pension pots accessed in 2013 were used to purchase an annuity, this figure has fallen to around 12% of pots since April 2015, it said.
Whether to buy an annuity or use drawdown instead depends on many factors. The Government’s Pension Wise service offers free, impartial guidance to help you understand your options at retirement. You can access the guidance online at www.pensionwise.gov.uk or over the telephone on 0800 138 3944. Fidelity’s Retirement Service also has a team of specialists who can provide you with free guidance to help you with your decisions. They can also provide advice and help you select products though this will have a charge.
The value of investments and the income from them can go down as well as up, so you may get back less than you invest. Withdrawals from a pension product will not be possible until you reach age 55. Tax treatment depends on individual circumstances and all tax rules may change in the future. You should regularly reassess the suitability of your investments to ensure they continue to meet your attitude to risk and investment goals. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.
Live the life you want
When it comes to the big things in life, preparation matters – and we’re not just talking savings. We’ve pulled together lots of ideas to help you get ready.